Rev. Rul. 74-63

Advice has been requested regarding the taxation of a Swiss resident under the circumstances described below.

The taxpayer, a nonresident alien individual of the United States and a resident of Switzerland, was engaged in an industrial undertaking in Switzerland and was also engaged in a trade or business in the United States through a permanent establishment during his taxable year 1972. He received dividends from United States sources during such year which were not effectively connected with the conduct of such trade or business in the United States. The taxpayer also received income from sources without the United States during his taxable year 1972 that was effectively connected with the conduct of his trade or business within the United States within the meaning of section 864(c)(4)(B) of the Internal Revenue Code of 1954.

The questions presented are (1) whether the taxpayer's United States source dividend income that is not effectively connected with the conduct of a trade or business within the United States may be treated as income that is effectively connected with the conduct of a trade or business within the United States, and (2) whether the taxpayer's foreign source income that is effectively connected with the conduct of a trade or business within the United States is exempt from United States tax under the United States-Swiss Confederation Income Tax Convention, T.D. 6149, 1955-2 C.B. 814.

With respect to question number (1), section 871(a) of the Code imposes a 30 percent tax on the gross amount of certain types of income, including dividend income received by a nonresident alien individual from sources within the United States, if such income is not effectively connected with the conduct of a trade or business within the United States. Section 871(b) provides that a nonresident alien individual who is engaged in trade or business within the United States during the taxable year is taxable at graduated rates, as provided in section 1 or 1201(b), on taxable income that is effectively connected with the conduct of a trade or business within the United States.

Income derived by the taxpayer from his trade or business conducted through a permanent establishment in the United States is taxed in accordance with section 871(b) of the Code and his United States source dividend income not effectively connected with the conduct of his United States trade or business would, absent any other provisions of the Code or the Convention, be taxed at the 30 percent rate in accordance with section 871(a). However, section 894(b) provides, in effect, that for purposes of applying any exemption from, or reduction of, any tax provided by any treaty to which the United States is a party, a nonresident alien individual or a foreign corporation shall, with certain exceptions not here pertinent, be deemed not to have a permanent establishment in the United States at any time during the taxable year, only with respect to income that is not effectively connected with the conduct of a trade or business within the United States.

Article VI(1) of the Convention, in effect, provides for a reduced rate of tax (15 percent) in connection with dividends received from United States sources by a resident of Switzerland not having a permanent establishment in the United States.

In the instant case, by virtue of section 894(b) of the Code which does not provide for an election, the taxpayer is deemed not to have a permanent establishment in the United States with respect to his United States source dividend income. Except for the election under section 871(d), relating to the treatment of real property income, no option exists under the Code whereby the taxpayer may include United States source income that is not effectively connected with his conduct of a trade or business in the United States with his income that is effectively connected with his permanent establishment in the United States.

Accordingly, for his taxable year 1972 the taxpayer's United States source dividend income that is not effectively connected with the conduct of a trade or business within the United States cannot be treated as income that is effectively connected with his conduct of a trade or business within the United States. Such dividend income is taxable at 15 percent as provided in Article VI(1) of the Convention in lieu of 30 percent as provided in section 871(a) of the Code.

With respect to question number (2), section 864(c)(4)(B) of the Code provides, in part, that income from sources without the United States shall be treated as effectively connected with the conduct of a trade or business within the United States by a nonresident alien individual if such person has an office or other fixed place of business in the United States to which such income is attributable and such income is of the type described therein.

Article III(1) of the Convention provides, in part, that a Swiss enterprise shall not be subject to taxation by the United States in respect of its industrial and commercial profits unless it is engaged in trade or business in the United States through a permanent establishment situated therein. If it is so engaged, the United States may impose its tax upon the entire income of such enterprise from sources within the United States.

Article II(1)(h) of the Convention provides the following:

The term "industrial or commercial profits" includes manufacturing, mercantile, mining, financial and insurance profits, but does not include income in the form of dividends, interest, rents or royalties, or remuneration for personal services: Provided, however, that such excepted items of income shall, subject to the provision of this Convention, be taxed separately or together with industrial or commercial profits in accordance with the laws of the contracting States.

Article III(1)(a) of the Convention, however, authorizes the taxation of only the United States source income of a Swiss enterprise that is engaged in trade or business in the United States through a permanent establishment. Section 894(a) of the Code provides, in effect, that income to the extent required by any treaty obligation of the United States, shall be exempt from income tax. See also section 110 of the Foreign Investor Tax Act of 1966, P.L. 89-809, 1966-2 C.B. 656, 690, which provides, in part, that no amendment made by this title (Title 1) shall apply in any case where its application would be contrary to any treaty obligation of the United States.

Accordingly, the taxpayer's income for his taxable year 1972 from sources without the United States is exempt from United States income taxation under the Convention even though that income may be effectively connected with the conduct of the taxpayer's trade or business within the United States within the meaning of section 864(c)(4)(B) of the Code.